With some from the Federal Reserve’s no tapering announcement last month, 10-year Treasury yields have dipped 7% in the past 30 days. That is barely enough to dent a year-to-date rise of 43.4% and that increase could be a tell that the path of least resistance for rates is higher, not lower.
Rising interest rates claimed as victims some favored income-generating asset classes and sectors such as MLP, REITs, consumer staples and utilities. However, that does not mean all sectors wilt in rising rate environments. Some sector ETFs actually prove more than durable when Treasury yields head higher, but history does show investors should avoid defensive sectors as rates increase. [Utility ETFs Stabilize as Rates Take a Rest]
“All of the defensive sectors displayed a negative relationship to rising yields, as shown through the 10-year yield beta metric. The Utilities and Telecommunication Services sectors showed the highest negative sensitivity over the period. Now, past performance does not guarantee future results, but if this relationship holds, you might expect these sectors to underperform the S&P 500 Index during a rising rate environment,” said WisdomTree Research Director Jeremy Schwartz in a new research note. [WisdomTree: Sector Sensitivity to Rising Rates]
Citing Ned Davis Research Group, Schwartz notes that for the 36-month period ending July 31, 2013 S&P 500 staples, telecom and utilities had an average negative beta of almost 10 to 10-year Treasury yields. Conversely, cyclical sectors displayed positive relationships to rising Treasury yields.
“The Financials and Energy sectors showed the highest positive sensitivity over the period. If this relationship were to hold, you might expect these sectors to outperform the S&P 500 Index during a rising rate environment,” said Schwartz.
Industrial ETF such as the Vanguard Industrials ETF (VIS) and the Industrial Select SPDR (XLI) are also among the ETFs investors may want to evaluate if 10-year yields resume their flirtation. On a historical basis, only consumer discretionary stocks outpace industrials in rising interest rate environments. [Industrial ETFs for a Year-End Rally]
The discretionary sector has lived up to its billing as a valid rising rates play. Over the past three months has 10-year yields are up 6.2%, the Consumer Discretionary Select Sector SPDR (XLY) has gained 7.5%.
“The recent spike in Treasury yields has caused a reevaluation of many equity strategies and an underperformance for the sectors with the highest dividend yields—typically Utilities and Telecommunication sectors. Investors should potentially look to the higher-growing and lower-yielding sectors in order to lower their portfolios’ sensitivity to potential further increases in Treasury yields,” said Schwartz.
Consumer Discretionary Select Sector SPDR
ETF Trends editorial team contributed to this post.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.